If you’ve decided to lease a new car, you might be a bit confused about how your payments are determined. Part of the problem is that there are a number of factors that determine your bi-weekly or monthly payments, so we broke down the main aspects for you here. We even threw in some tips that can help lower your payments!
The Basics: How Leases Work
In general terms lease payments start with the whole value of the vehicle you want, which is called the Selling Price. By the end of your lease, the car will have what is called the Residual Value, which represents how much the vehicle can be re-sold for by the dealership when you return it to them. How much you wind up paying for the vehicle is mainly determined by how much the vehicle loses in value over the term of the lease, which is called the Depreciation.
At this point, there are other factors that can raise or lower your lease payments accordingly. Below we will discuss all the main factors.
Is Selling Price the Same as MSRP?
The Selling Price of the vehicle comes from the usual negotiations you have with a dealership when buying a car to determine how much you would buy it for. They usually involve the following:
- Manufacturer’s Suggested Retail Price (MSRP) – used as the opening mark for negotiations with the dealer but it is NOT the same as the Selling Price
- Discounts – any incentives, rebates or bonuses reduce the price
- Negotiations – further negotiating with the dealer can further reduce the price
All of this helps determine the final Selling Price of the vehicle before tax is included. It is generally used as the foundation for the other factors below.
What is Residual Value & Depreciation?
The Residual Value and the Depreciation of the vehicle are closely tied together. Both are determined by the leasing company before you sign the lease using historical data for that make and model as well as future projections. The Residual Value represents how much the car is worth at the end of the lease, and the Depreciation represents how much value the vehicle lost by the time the lease ends. Here is a basic rundown of how they work to determine your lease payments:
- The Selling Price of a vehicle you want to lease is $30,000
- By the end of a three-year lease the vehicle is now worth $17,000 – this is the Residual Value
- The Selling Price ($30,000) minus the Residual Value ($17,000) leaves $13,000 – this is the Depreciation
- Your lease payments are mostly to cover the $13,000 in Depreciation on a monthly basis over the term of the lease
It is important to keep in mind that the Residual Value and Depreciation are determined before you actually lease the vehicle, not after the lease is over. They are both set using historical data of previous versions of the same model as well as forecasting future trends. Other factors that are considered include reliability, the cost and frequency of repairs and parts, fuel economy, size, condition, mileage, consumer trends in desirability, and so on.
Can I Make a Down Payment or Trade-In My Old Vehicle?
Some leasing companies will ask for you to make down payment towards the lease that will also lower your lease payments. The bigger the down payment, the lower your monthly payments will be. However, this does not necessarily save you any money in the long run. Usually a down payment is just divided by the number of months in the lease which then lowers the monthly payments by around that amount.
If you have the money upfront and want to get that much out of the way for the future, it can be a viable option. The down payment is still taxable however, so check how that affects the monthly payments so you can see if it saves or costs you any money. Whether you prefer making a down payment or not will depend on your personal preferences and circumstances.
Alternatively, if you already own a car that you want to sell, you can trade it into the dealer. It acts similar to a down payment but uses your old vehicle’s value instead of cash you have to have saved up. You can then use the value of the trade-in to reduce the taxable leased amount you have to pay, which further reduces your monthly payment. This only works for a vehicle that you own, as you cannot trade in leased vehicles.
Does the Length of My Lease Matter?
Leases usually are between three to four years (36 to 48 months) long, but can be as short as two years and as long as five. How long of a lease you choose will affect your monthly lease payments, and generally speaking the longer the lease the lower your monthly payments. Here are the main things to consider when it comes to longer leases:
- Your payments can be spread out over more months
- Your vehicle will depreciate more over time so you aren’t just spreading the same total amount over more time
- Cars depreciate at the highest rate in the first year of ownership so the extra depreciation you’d pay for additional years would not be as significant
You can look up depreciation and lease calculators for models you are interested in to see whether or not a longer lease would be better or not, but don’t sign a lease until you are sure that it makes sense for you.
If your lease is longer than your warranty coverage you might be on the hook for maintenance and repairs so make sure you know how the vehicle’s warranty works before leasing it
How Does The Kilometers Limit Affect My Payments?
Leases generally impose a limit on how much you can drive the leased vehicle per year, with additional payments as penalties if you surpass it. This is because the amount driven affects Depreciation, so more kilometers on the odometer will cause it to be worthless. Since the Depreciation for the leased vehicle is set at the start to determine your payments, it will be based on a forecasted amount driven over the term of the lease.
For someone who lives in Toronto and doesn’t really drive much outside of the city, staying below this limit would not usually be difficult, But for someone who lives in the suburban areas around it, like Mississauga, or in more rural areas and need to use their car for greater distances they are more likely to surpass the usual limit number.
How Does a Security Deposit for My Lease Work?
Most leases require you to make a security deposit that is usually around the worth of one month’s lease payment. You effectively pay down one month’s payment in advance that the leasing company will use in case you fail to make a payment or against damage caused to the car. However, you do get the security deposit back by the end of the lease as long as the car is in good condition.
There are other factors that determine your lease payments, such as taxes and interest rates. They vary greatly depending on the person and where they are located, however. You can consult your bank or dealership to get an idea for what to expect in those areas. The above list represents the most significant factors as well as some tips on how you can keep your monthly payments lower. Make sure to do all your homework and research before signing a lease, and enjoy your new car!